In its Net Neutrality Comments, Free Press combines a limited number of less-than-ideal data points with a faulty methodology and a misleading narrative to claim that has "proven" its' reckless accusation that ISPs arelyingwhen they express concerns that Title II reclassification/regulation may distort their incentives to invest in network improvements.
In the previous post, we discussed some of the problems with the methodology, reasoning, and data Free Press uses to reach its conclusion. Today, we'll correct Free Press's misleading narrative "interpreting" the data with some relevant facts that you wouldn't know if you only read their comments.
Ironically, Free Press concludes its misleading presentation of capex "facts" (Comments III.B and III.C) by stating, "[w]e hope that the Commission and other policymakers learn and understand this history, for this debate cannot be a legitimate one if basic historical facts are replaced by incorrect beliefs." Comments at 111 (emphasis added). This statement would be OK (but still too preachy), if it didn't just present the FCC with a version of history so tailored for advocacy that it exists only in Free Press's comments. But, it's easy to forget . . .
Excessive Investment=Excess Capacity=Loss of Investment + Jobs
Free Press speaks of the period before the Cable Modem Order (in 2002) with a level of nostalgia that would seem more appropriate to a former WorldCom executive than a group claiming "historical facts." Free Press confidently asserts,
[common carriage], in conjunction with policies that opened up communications markets to greater competition, also was responsible for the largest period of telecommunications industry investment in U.S. history.
Comments at 90. The only hint from Free Press that this period may not have been an unqualified success is when Free Press allows that, "[m]uch of this investment . . . was a bubble ...." Comments at 111.
Perceived Bandwidth Demand Drove CapEx. Internet traffic grew at incredibly high rates in the second half of the 1990s, but the Internet was new to most people, and the subject of a lot of hype. Thus, perceived Internet traffic growth not only outpaced actual Internet traffic growth, but it was also disproportionately affecting perceptions of total bandwidth demand. But, where would people get these ideas?
Well, in a March 2000 report to Congress, then-FCC Chairman William Kennard stated,
Internet traffic is doubling every 100 days. The FCC's 'hands-off' policy towards the Internet has helped fuel this tremendous growth.
(emphasis added). Kennard's predecessor, Reed Hundt, would have none of this foolishness, and wanted people to know that "[i]n 1999 data traffic was doubling every 90 days." (emphasis added) ( Quote is from Hundt's self-congratulatory book, "You Say You Want a Revolution"at 224.)
The Reality. Not everyone at the FCC was buying (or selling?) the hype. A senior economist at the Commission, Douglas Galbi, published a paper the same year (2000), warning that total bandwidth demand was not as high as everyone seemed to think.
Growth of bandwidth in use for Internet traffic has been dramatic since 1995, butInternet bandwidth is only a small part of total bandwidth in use. . . .
(emphasis added). Meanwhile, massive fiber deployments and innovations in optical transmission equipment meant that capacity was about to explode.
The Reckoning. Only a year after Kennard's report to Congress, CNET reported that the U.S. was in the midst of a bandwidth glut, and that prices would likely decline much further. By summer 2001, the equipment companies issued clear warnings that the unraveling was well underway. A few months later, the Enron scandal would break.
Over the next year, what followed was the largest dislocation, in terms of job loss (500,000) and wealth destruction ($2 trillion) the telecom industry has ever seen. See, e.g., this BusinessWeek article. Law professor Dale Oesterle writes that the telecommunications industry in 2002 may have been the largest, most scandal-ridden, industrial meltdown in U.S. history.Here at 1.
The Aftermath. After the telecom bubble burst, depressed Internet transport prices would continue well into the middle of the decade. If you're wondering how low
In 2006, Level 3 needed additional transatlantic capacity, so it purchased 600Gbps of lit capacity on another carrier's transatlantic fiber. At the time of this purchase, though, Level 3 was carrying 480Gbps of traffic on its own transatlantic subsea cable system; a system that was scalable to 1.28Tbps. In other words, Level 3 already owned unlit transatlantic capacity, but using its own fiber didn't make sense because wholesale prices had dropped below operational and replacement costs!
The Biggest Lie About Capital Investment
The central deception of Free Press's entire misleading capex narrative is, of course, the notion that the 2002 Cable Modem Order was the defining event for broadband Internet capital investment. As explained above, the telecom bubble had little to do with Title II, and neither did the bust. Moreover, broadband Internet services, in particular, benefited more from the bust (post Title I classification), than they did from the boom.
The cheap [below-cost] Internet bandwidth of the early/mid-2000s led to a lot of web application experimentation and new Internet companies. Consumers responded quickly, and favorably, to the new, high bandwidth Internet applications, like Myspace. Xbox, and Youtube.
This led to strong consumer broadband Internet adoption, which could not have been possible if the broadband ISPs had under-invested in their networks. The FCC data show broadband Internet services increased by a factor of about 4.5 between 2002 and 2008; from 17 million customers in 2002 (see Table 3) vs. around 75 million telco and cable broadband customers in 2008 (see Table 1).
Indeed, this 400-500% increase in demand for broadband Internet service compares favorably with total bandwidth demand growth of around 300% during last half of the 1990s. See Galbi at Table 2. In fact, the success of the broadband Internet economy (Internet companies, backbones, metro fiber providers, and broadband ISPs) from 2002-2008 would finally end the bandwidth glut, and bring back demand for new "Title II" Internet transport capacity, including transatlantic capacity.
Free Press tries to prove that broadband ISPs are lying about their concerns with potential new, and undefined, rules under a Title II reclassification. But, if the FCC is tempted to change its regime based on erroneous cause-effect propositions that ignore historical facts, then it would seem the broadband ISPs have every reason to fear the unintended effects that will accompany a new regulatory classification.
It's no secret that Net Neutrality pressure group Free Press would like the FCC to revisit the 2002 Cable Modem Order, in which the FCC classified broadband Internet service over cable as an "information service." Nor is it a secret that the largest broadband ISPs oppose such a reclassification.
The ISPs often contend that a reclassification of broadband Internet service as a Title II, or "common carrier" service, would open the door to a range of regulations that could dampen or distort their incentives to invest in network improvements. But, in its comments on the FCC's Net Neutrality NPRM, Free Press intends to conclusively vanquish the "investment fear" arguments of the ISPs once and for all.
Free Press believes it can "debunk" the "myth" that Title II discourages regulated firms from investing in their networks if it can show that the broadband ISPs invested heavily in their networks at a time when the ISPs' broadband services were (pretty much) subject to Title II classification. Free Press relies on revenue and capital expenditures from the annual reports of a cross-section of large, publicly-traded, telecom and cable companies to tell the Commission a fairy tale.
Perhaps everything that could be wrong with Free Press's facts and theory about ISP network investment over the last 20 years is wrong--starting with the theory itself. This blog will focus on the problems with Free Press's theory, and its limited set of "facts" in support of its theory. Tomorrow, we'll explain what really happened (using Free Press's data, along with other relevant historical facts), and why Free Press's narrative is so misleading.
Investment Itself Is Never an Appropriate Regulatory Goal
Free Press seems to equate periods of rising capital investment as a "good" outcome, and periods of falling investments as a "bad" outcome. However, regardless of whether the investment was efficient or not (it isn't), the FCC should never try to assume the role of central economic planner. The FCC's only interest in investment should be to make sure that consumer interests are served in the manner that least distorts company investment incentives.
CapEx from Financial Statements Doesn't Show What Free Press Thinks It Does
Even if stimulating investment was the right focus for the Commission, the capex information Free Press presents does not prove that Title II is the answer. If Free Press is trying to show that the regulatory classification of consumer broadband service affects how much a firm invests in that service, then aggregate, firm-wide network investment wildly overstates mass-market broadband investment in any period.
In Fig. 1 (Comments p.100), Free Press tracks capex for a number of telecom carriers over time. But, by using aggregate enterprise capex, Free Press is primarily tracking capex for Title II services in all relevant periods. Notwithstanding the regulatory classification of one residential service, the majority of the revenue produced by these firms' networks still comes from Title II services (e.g., both AT&T and CenturyLink reported record numbers of residential broadband customers in 2Q 2014, but this service only comprised ~16.5% of total firm revenues for both firms).
A more accurate estimate of the capex devoted to the Title I service would focus on correlations between significant broadband subscriber growth and increased (decreased) capital investment over the same period of time. For example, CenturyLink has tripled its broadband subscribers (from ~2m to ~6m) over the last 5 years; during this same period, capex has grown at a CAGR of over 60%. See here (figures are from 2013 Annual Report, and the 2Q 2014 Earnings Supp. spreadsheet). A more careful review of the companies' data, however, may not support the story that Free Press wants to tell.
Investment and Revenue Figures from the Late '90s Are Not Entirely Accurate
Even if we accept that "investment" is a worthy regulatory goal, Free Press paints a misleadingly "rosy" picture of the era. Free Press concludes its recasting of the "golden age of investment under Title II" by simply stating that, "the 2001 recession and the economic impact of the September 11th attacks took their toll on the U.S. economy, and the telecom sector wasn't spared." (Comments at 101)
Free Press neglects to mention the devastating accounting scandals that would surface right after 9/11, or the massive layoffs, bankruptcies, and distress sales that would follow, and cascade through the industry over the next two years.
On October 16, 2001, Enron announced it would have to restate its earnings for the prior 2 years. This statement, and the subsequent SEC investigation, would uncover widespread accounting fraud throughout America's largest companies.
When you look at this list of the accounting scandals that were exposed in the 11 months after 9/11, don't focus solely on the telecom and cable companies. Keep in mind that every energy company on this list also owned significant telecom network assets. (See this 2002 study at p. 21/38).
Bandwidth trading. If you're wondering why most of the accounting scandals involved telecom or energy firms, that's because they had a common thread. Most of the telecom-related accounting fraud was related to "bandwidth trading." If you don't know what bandwidth trading is, just listen to Enron explain it.
The idea of bandwidth trading was just a few years ahead of its time. In practice, it would take BitTorrent and The Pirate Bay to make using someone else's capacity while they were sleeping a reality.
Early bandwidth traders, like the modern P2P thieves users, did not actually exchange money. Rather, if you had bandwidth on one route, and another company had capacity on a route you wanted, you could just swap capacity--but that's boring. Instead, each party would "pretend pay" the other for the prevailing value of the capacity (which still seems kind of dull).
The real fun came with the accounting. Both parties could record each other's pretend payment as real revenue, and record the capacity they were giving up as a capital expenditure; winning! For more, see this 2002 Wall Street Journal article. Oh, and when I say "could record," I mean literally; not legally.
As you can see, Free Press makes a number of mistakes in its attempt to prove that their Net Neutrality opponents could never justifiably fear Title II regulation--from trying to prove that a fear of undefined future regulations is unwarranted, to a misunderstanding of what their data actually show. Tomorrow, we'll explain what actually happened in the golden age of Title II and why Free Press's narrative is so deceptively misleading.
Earlier this week, the Internet Innovation Alliance released a study on old networks, new networks, wireless networks, red networks, blue networks; who's using them, and how much they cost. Coming in at 45 pages, including numerous pictures (each worth ~1000 words), the IIA had more to say than Sen. Ted Cruz on bath salts. Luckily, you've got me to unpack this baby for you.
In short, the IIA report dramatically shows what every FCC commenter has ever said in support of their comments: and that is that if FCC adopts the regulatory (vs. de-regulatory) policies advocated, then these policies will promote investment above and beyond the level necessary to deliver the regulated service. To be clear--FCC regulations (they have to be affirmative burdens on regulated firms) promote investment.
Let's take a closer look. According to IIA, only 5% of households depend on "POTS" (plain old telephone service), and the switched telephone network handles only about 1% of the voice traffic handled by IP networks (wireline + wireless + cable + CLEC). Yet, and here's the kicker, from 2006 through 2011 more than half of incumbent LEC investment was used to support the POTS network in order to comply with . . . wait for it . . . FCC regulations!
This investment--which was clearly not necessary to deliver voice service to consumers--amounted to over $13.5 billion dollars/year. This is investment that can only be attributed to successful regulation. I'd say former Chairman Julius Genachowski has something else to crow about . . . as if he needed another feather in his cap.
The impact of this report cannot be understated. The Commission has scarcely seen such vindication of its efforts. While the IIA tries to shy away from its pro-regulatory conclusions by saying that but for the FCC's legacy rules, more resources would have been diverted to providing advanced IP services that consumers want to use, this is idle speculation from self-interested parties. The IIA knows full well that maintenance of this "museum network" is critical to our country's economic recovery.
Interestingly, the IIA study confirms what the left has been saying for years: cable needs to be regulated. Why? Well regulation certainly won't make them better companies--apathy is in their DNA--but regulation will make them pay their fair share. Take, for example, Comcast's customer service rating: a resounding "disappointing", but only a step away from "terrible." Verizon comes in almost even (the result you would expect in a competitive market).
The only difference between the two companies? Verizon is contributing to the economy, and Comcast is getting a free ride--regulation-wise. If Comcast were regulated, would they all of a sudden improve by providing "mediocre" or "somewhat acceptable" customer service? No! Of course, not--they would in all likelihood remain competitive with Verizon, but they would be contributing to US economic development.
Perhaps the party that comes off looking the worst out of this study is US Telecom. US Telecom, in case you don't know, is the trade association of the incumbent LECs, and US Telecom has repeatedly fought the Commission's efforts to preserve these pro-recovery, pro-investment regulations.
US Telecom filed an extensive petition last year explaining why a ton of legacy regulations no longer serve any useful purpose. In fact, US Telecom has another petition pending with the Commission right now, seeking to remove some of these regulations by having its members declared "non-dominant" in the provision of wireline telecommunications services.
In its arguments, US Telecom conveniently fails to list "investment" [for the sake of regulation] as a useful purpose of regulation. This omission, of course, makes the US Telecom requests look deceptively reasonable.
Hopefully, the Commission will see through this shameless ploy and do what's right for the economy. Frankly, it matters little whether 5% or .0005% of consumers use incumbent LEC wireline services: dominant is dominant, and dominant = regulations, dammit. You know who "gets it?" The competitors of the US Telecom members, that's who.
Because of the government shutdown (costing countless jobs from regulations that are simply not being adopted), I couldn't check the FCC website to see who else had the foresight to oppose the US Telecom petition, but I did manage to find these opposition comments from CompTelhere and here. Thank goodness someone cares about preserving the investment burdens incentives of their competitors.
Whatever you think might be the purpose for which the FCC was created, you're probably wrong. Congress explains the purpose of the Commission in one gigantic, and barely comprehensible, run-on sentence contained in Section 1 of the Communications Act of 1934. To make it easier, I'll break it into a couple sentences.
The goal of the Act was to ensure that citizens had nondiscriminatory access "to rapid, efficient, Nation-wide, and world-wide radio and wire communications services" with "adequate facilities at reasonable charges." Radio and wire communication services are to be made available at reasonable charges for the "purpose of national defense" and to "promot[e] the safety of life and property."
The first few times you read it, this provision sounds reasonable; if only because Congress uses the word "reasonable" twice in the same really long sentence.
Now that you know the purpose of the Act, what do you think this FCC thinks its purpose is? If you didn't have the context of the Act and you only looked at the Chairman's bio, you would be forgiven for thinking he was the Chairman of some kind of mini Federal Reserve Bank for the telecommunications industry. The notion of promoting investment is mentioned more than any other single concept, and "job creation" is also listed prominently in the first paragraph.
To be fair, there isn't anything flatly antithetical to the FCC's official purpose in any FCC Commissioner's literature, speeches, or statements. This is the problem. The breadth of the Act's purpose almost certainly ensures that no two FCCs will define their focus or their actions in any consistent way. The only person I've ever heard offer a solution is Jim Cicconi of AT&T.
His point is so non-controversial that it's easy to miss. All he says is that the FCC should be "re-chartered" by Congress to focus on consumer protection. The problem, he argues, is that the public--and many members of Congress--expect the FCC to act whenever a consumer issue arises.
But, he explains, because the legislatively-defined purpose is not well-suited for the public's expectations of the FCC, "it leads [the FCC] into some adventurism in interpreting their own statutes." Here is a report of his quote in 2008, again almost 4 years later at a Phoenix Center event, in his own words here, and again in May of this year here.
You know what's weird about this statement? I've only heard it from Cicconi. I must have spent more than 5 hours looking at Internet search results to try to get some other cite for this idea. But, I couldn't find anything by anyone saying anything similar. It's just him!
The better question is why no one else has raised this point? My guess is that most people think that the official "purpose" of the FCC is written so broadly that Congress wouldn't need to change a thing for the FCC to focus on consumer protection. Again, this is a problem.
Look back at what the Chairman says is his focus. Is it any wonder that it's become cliché-like for someone on every side of telecom policy debates to argue that the FCC should decide in their favor because it "promotes investment?" Likewise, the statement that a regulatory policy "promotes investment" has become almost boilerplate in every major FCC Order over the past few years.
But, "investment", or "promoting investment" can never be meaningful regulatory goals, because these terms offer the regulated firms no transparency of purpose or predictable consistency across political administrations. Regardless of whether the regulator sides with one industry group or another, in a carrier-centric scheme the regulator can always say it is "promoting investment" by the "winning" side. Changes in technology, as well as changes in political dominance, virtually guarantee an artificially-distorted regulatory environment.
The value of the last point cannot be understated. Because a carrier-centric regulator will necessarily create policies with disparate effects on competing companies, these disparities in regulation will always find a political voice.
The result is what we have now--unproductive partisan bickering over the economic interests of competing firms. The voice of the consumer gets lost in this cacophony, if it ever finds its way into these quarrels at all.
On the other hand, if the regulator is charged with the clearer obligation to focus on protecting the interests of communications consumers, regardless of the "regulatory classification" of the offending firm, then regulated firms can more easily discern the future expectations of the regulator.
The almost zen-like paradox of Cicconi's proposal is that the regulator cannot promote investment by focusing its decisions on the investment of the regulated firms. Rather, the regulator must have some transparent focus on something other than the business models of competing firms.
An explicitly consumer-focused regulator would have the ability to redress consumer harms perpetrated by any company that contributes to a communications service that consumers purchase. Not only will consumers enjoy greater protection, and less confusion as to which state or federal agency can resolve their concern, but communications firms will benefit from a certainty not possible today, and both the FCC and Congress will also enjoy the same clarity of focus.